Sunday, August 31, 2014

Chief Counsel Squashes Mysterious Technique

I hate it when somebody comes up with a dastardly plot and I still can’t figure out what they were up to after it has been exposed. Of course the essence of masterful villainy is for no one to be the wiser about it. Villains who gloat about the details of their plots usually don’t do that well in the end. The designers of the Split Eligible Interest Transaction seem to be keeping quiet about what they were up to.

Whatever it is that the ﻿designers of the ﻿﻿﻿﻿﻿Split Eligible Interest Transaction were up to has been squashed by the

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Associate Chief Counsel in AM 2012-002. I got the basic concept. You take an LLC and create several classes of membership. All the classes are owned by the same person. So the LLC is a disregarded entity. For tax purposes it is as if its assets are owned directly by the owner. The gist of the ruling is that the owner was trying to do some sort of manipulation based on the different classes. Whatever the manipulation was the Associate Chief Counsel does not like it and will not let if be allowed:

﻿﻿For example, in a Split Eligible Entity Interest Transaction, Owner creates a wholly owned state law entity, treated as a disregarded entity for federal tax purposes. The entity’s governing documents state that Owner takes one-hundred percent of each class of interest in the entity. Based on the preferences contained in the governing documents, the entity allocates items of income, deduction, loss, and credit between the classes. Owner tracks and adjusts an outside basis in its various classes of interests accordingly. Owner drafts the governing documents to establish Owner’s chosen class interest allocations. Thus, adjustments to Owner’s bases in the various classes of interests will create disparities based on the entity’s items of income, deduction, loss, or credit. Such disparities will exist in spite of the fact that the entity is a disregarded entity, and Owner should recognize all of the entity’s items of income, deduction, loss, or credit directly regardless of any supposed “allocations” among artificially created classes of interests.

This artificial manipulation of the interests, if permitted, would allow Owner to control the recognition of income or loss on distributions from the entity or dispositions of its interests in the entity for federal tax purposes.

While state law may or may not allow for different classes of interests in eligible entities for federal tax purposes, such interests have no effect for federal tax purposes because a wholly owned eligible entity is a disregarded entity unless it elects otherwise. Therefore, for federal tax purposes Owner may not split its interest into separate classes of interests and may not allocate items of income, loss, deduction, credit, and basis among those classes.

The Service position is really clear. The various classes of ownership in a disregarded entity do not have any tax effects. What is still a little mysterious to me is what possible effects someone could have argued were there. KPMG which has a history of doing fascinating things with basis hassomething on the Chief Counsel Advice, but it sheds no further light on what was behind this. Perhaps we will never know.

A common contribution is essential for the maintenance of the public forces and for the cost of administration. This should be equitably distributed among all the citizens in proportion to their means.

Declaration of the Rights of Man

Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.